arbitrage tutorial

This tutorial is aimed at those who wish to gain a basic understanding of, and understand the methods involved in, arbitraging.

Win or lose – you win!

Do you like the ide you like the idea of profiting from a horse regardless of whether it wins or loses? Then ARBITRAGING is definitely for you and you are invited to read on.

What is Arbitraging?

The word Arbitrage is derived from the French word arbitrer which means to ‘give judgement’.

One dictionary defines Arbitrage as ‘the simultaneous buying and
selling of assets in different markets or in derivative forms, taking
advantage of the differing prices.’ A second defines it as the trading
of one currency for another in the hope of taking advantage of small
differences in the currency conversion rates in order to achieve a
profit. For example, if $1.00 buys £0.7, £1 buys 9.5 Euros and 1 Euro
buys $0.16, then an arbitrage trader who starts with $1.00 earns: 1 x
0.7 x 9.5 x 0.16 = $1.064. This produces a profit of 6.4 cents or 6.4
percent. 6.4 cents doesn’t seem much but if, instead of trading $1, we
trade $1,000,000, the profit would be $64,000!

From the above, it can be seen that Arbitragingisn’t about buying or selling anything. It’s about deciding whether the price of an item will increase or decrease in value and taking advantage of the price movement.
A currency trader doesn’t buy or sell a currency with the intention of
keeping it. The trader only buys a currency to sell it at a profit.

So, what has all this got to do with horse racing and betting in general?

The best way to describe arbitraging is by way of the following examples:

Let us assume that a horse called ‘Arbit’ is running in the 3:30 race at Sandown. The odds to lay Arbit to lose on one of the betting exchanges is 5.0. (The odds on betting exchanges are expressed in decimal form, by the way). If you feel that that the odds on Arbit will increase before the start of the race, you should place a bet on Arbit to lose. Then, when the odds have increased, you should place a bet on Arbit to win.

Let’s work through this example:

If you were to place a £10 bet on Arbit to lose, your liability on
this bet, should Arbit win, would be £40 ((£10 x (5.0 – 1.0)) = £10 x
4.0 = £40. In other words, if Arbit wins, you would lose £40. If Arbit
loses, you would win £10.

If the odds on Arbit then increase, for example to 10.0, you could
placed a bet on Arbit but this time to win. If you place a £5 bet on
Arbit to win at 10.0 and Arbit won, you would win £45 ((£5x(10.0 – 1.0) =
£5 x 9.0 = £45). If Arbit lost, you would lose your stake i.e. £5.

Now let us look at all of the the possible outcomes of the race from Arbit’s point of view: There are only two: Arbit wins or Arbit loses the race.

Now let’s look at the net effect of the two bets based upon the race outcome:

Result

Arbit Wins

Arbit Loses

Win Bet

+£45

-£5

Lay Bet

-£40

+£10

Net Effect

+£5

+£5

Notice that, irrespective of whether Arbit wins or loses, the profit is the same; £5.

What has actually been achieved by placing the two bets? A bet was ‘purchased’ on Arbit at a particular price and re-sold at a higher price, thus making a profit
in the process. What actually happened was that a bet was sold on
Arbit to lose for £10 (the lay bet) and a bet was purchased on Arbit to
win for £5 (the back bet). The result was a £5 profit. The result of
the race was immaterial.

We have now dealt with the case where we think that a horse’s odds will increase. Now let’s deal with the case where we think that a horse’s odds will decrease.

Let us again suppose that ‘Arbit’ is running in the 3:30 race at
Sandown and that the odds on Arbit are 5.0. If, this time, we think the
odds on Arbit will decrease, we could place a bet on Arbit to win, wait
for the price to fall and then place a bet on Arbit to lose.

Now let’s work through the following example:.

Let’s place £5 on Arbit to win at odds of 5.0. The potential profit
on this bet is £20 (£5 x (5.0 – 1.0)) = £5 x 4.0 = £20). In other
words, if Arbit wins the race, we win £20. If Arbit loses, we lose our
stake of £5.

If the odds on Arbit decrease, for example to 2.5, a second bet could
then be placed on Arbit, but this time to lose. Suppose that a £10 bet
is placed on Arbit to lose at 2.5. If Arbit loses, the liability will
be £10 x (2.5 – 1.0) = £10 x 1.5 = £15. If Arbit loses, we win £10.

Lesson # 2

Now let us look at all the possible outcomes of the race from Arbit’s
point of view: There are only two: Arbit wins or Arbit loses the
race.

Now let’s look at the net effect of the two bets based upon the race outcome:

Result

Arbit Wins

Arbit Loses

Win Bet

+£20

-£5

Lay Bet

-£15

+£10

Net Effect

+£5

+£5

Notice that, irrespective of whether Arbit wins or loses the race, the profit is the same; £5.

What has actually been achieved by placing the two bets? A bet was
‘purchased’ on Arbit at a particular price and re-sold at a higher
price, thus making a profit in the process. What actually happened was
that a bet was sold on Arbit to lose for £10 (the lay bet) and a bet was
purchased on Arbit to win for £5 (the back bet). The result was a £5
profit. The result of the race was immaterial.

This is what Arbitraging is all about. It isn’t about betting on the
outcome of a race. It’s about profiting from a movement of the odds on
a horse in a race, rather than on a horse’s performance. That is why
the outcome of a race is unimportant in arbitraging. What is important
in arbitraging is that the odds on a horse move in the predicted
direction. The more that the odds move in the predicted direction and
the greater the size of the bet, the greater is the profit.

So why not Arbitrage all of your bets?

If arbitraging a bet always leads to a profit, regardless of the outcome of a race, why wouldn’t we arbitrage all of our bets?

Firstly, the odds on a horse may remain fairly constant. As a
result, arbitraging a bet may not be possible and we will have to honour
the initial bet.

Secondly, the odds on the horse may move in the opposite direction to
the one anticipated. As a result, arbitraging our bet isn’t possible
and we will have to honour the initial bet.

Thirdly, if we arbitrage our bet, there is a penalty which we must
pay because you can’t have something for nothing – not in this world and
certainly not in horse racing! The penalty is that most of the profit
potential on a horse must be sacrificed in order to secure a smaller
arbitrage gain. Again, this is best explained by way of an example.

Let us suppose that our old friend ‘Arbit’ is running in the 3:30
race at Sandown. Let us further suppose that the odds on Arbit on one
of the betting exchanges is 5.0 and we place a £5 bet on Arbit to win.
The odds on Arbit then fall to 2.5 and we place a second (£10) bet on
Arbit, this time to lose. The situation is that, irrespective of
Arbit’s performance, we make a £5 profit.

Now let’s change the situation slightly. Let us suppose that we
place a £5 bet on Arbit to win at odds of 5.0 but we don’t place the
second bet (to lose). In other words, we do not arbitrage our bet.

If Arbit loses the race, we lose £5. If, however, Arbit wins, we win £20 .

If the bet had been arbitraged, a potential £20 win or £5 loss would
have been replaced by a certain £5 win. This is a case of ‘is a bird in
the hand worth two in a bush?’. Is a certain £5 win better than a
potential win of £20?. If you feel that it is, arbitrage is for you.

A Free Bet!

I asked you earlier if you liked the concept of a free bet. Let’s face it, who wouldn’t?

So, how do we achieve it?

Well there are two ways. Here’s the first:

From the above examples, you can see that we made a £5 profit on
Arbit, regardless of whether or not it wins. Simply place a £5 win bet
on another horse of your choice, either in the same race or in a
different race. OK – if your horse loses, you lose £5, but, you won it
from arbitraging Arbit anyway, so you won’t have lost anything. In any
case, if your selected horse wins, you can look forward to adding to the
£5 that you won on Arbit.

The second way is a little bit more complex:
To explain this method, we need to go back to the 3:30 race at Sandown and our old friend Arbit.

Let us suppose that the odds on Arbit is 5.0 and we place a £5 bet on
Arbit to lose. Our liability on the bet, should Arbit lose, is £20 (£5
x 4). If Arbit wins, we win £5. The odds on Arbit then begin to
increase until they reach 11.0. At this point, we could place a £2 bet
on Arbit to win. If Arbit wins, we would win £20 (£2 x 10.0). If Arbit
loses, we would lose £2.

Now let us look at all the possible outcomes of the race from Arbit’s
point of view: There are only two: Arbit wins or Arbit loses the race.

Now let’s look at the net effect of the two bets based upon the race outcome:

Result

Arbit Wins

Arbit Loses

Win Bet

+£20

-£2

Lay Bet

-£20

+£5

Net Effect

+£0

+£3

What have we achieved in placing the two bets?

The second bet nullified the liability of the first bet at a cost of
£3 less than that of the initial bet. As a result, if Arbit wins, we
break even. If Arbit loses, we win £3. What we have actually achieved
is to totally nullify the initial lay bet and leave ourselves a profit
of £3 that will be won if Arbit loses. In other words, we have created a
free lay bet on Arbit.

Lesson # 3

Reduced minimum stakes

This section is for the cautious investor who wishes to stake less
than the minimum allowed by the betting exchanges. On Betfair, for
example, the minimum stake is £2 per bet. Note that the minimum is
applied to the stake and not the liability. To illustrate this point,
suppose that you layed a horse to lose and the lay odds were 100.0 Your
liability on the bet, should the horse lose, would be (100 – 1) x £2 =
£198. To reduce your liability, you could place a £3 bet on the horse
to lose followed by a £2 bet on the horse to win.

What has this achieved?

Effectively, you have placed a £1 bet on the horse to lose and
reduced your liability, should the horse lose, to (100 – 1) x £(3 – 2) =
99 x £1 = £99. So, if the horse loses, you only lose £99 instead of
the £198 you would have lost had you placed the minimum allowed £2
stake. There is a down-side to this strategy, however. If the horse
wins, you would only win £1 instead of the £2 you would have won had you
placed the minimum £2 stake.

Using this strategy, you have placed less than the minimum £2 stake
on a horse. It should also be noted that on all betting exchanges, at
any one moment in time, the odds to lay a horse to lose are always
greater than the odds to back a horse to win. Therefore, the above
calculation will only be true if, at the time the win bet was placed,
the odds to back the horse had increased to 100.0.

Also, the odds may decrease between placing your lay bet and your win
bet. This would increase your liability beyond the anticipated £99.

Multiple Arbitrage

Throughout this article, we have referred to the arbitraging of one
horse on one occasion. There is nothing to prevent you, however, from
arbitraging one horse multiple times, arbitraging multiple horses once
or indeed arbitraging multiple horses multiple times. Here is an
example:

A friend of yours e-mails you. A friend of his is a stable lad. The
stable lad has told your friend about three horses that are running in
the 3:30 at Sandown this afternoon.

The first horse is called Purple Patch. It did some exceptional work
on a training gallop two days ago. The horse is fit and raring to go.
If it doesn’t win, it will come close. It is definitely worth an ‘each
way’ bet. Its odds, at the moment are 10.0. It is fifth favourite.

The second is Bank Balance. Although this horse easily won its last
race ten days ago, it has not been training well of late and may benefit
from a rest. Its last race apparently took more out of the horse than
was originally anticipated. Bank Balance is therefore unlikely to run
well. It is currently the race favourite at odds of 2.5. Its
favouritism is purely based on its last race.

The third is Arbit. In his last race, Arbit came second behind a
very well regarded horse who has since gone on to record another win.
That race took a lot out of Arbit and it would probably benefit from a
rest. As a result, it is very likely that Arbit will finish close to
the back of the field. It is currently second favourite in the betting
at odds of 4.0. This is largely based on its last performance.

Your friend tells you that the information about the three horses is
not widely known at the moment. As such, their odds do not fully
reflect this information.

Based on your friend’s comments, you decide that when the information
that he gave you becomes widely known, and knowing your friend – it
will, the odds on Purple Patch will fall and the odds on Bank Balance
and Arbit will increase.

You then send e-mails to all of your friends giving them the
information, knowing that most of them will pass the information on to
their friends.

One hour later, you visit the betting exchange again. You notice
that the odds on Purple Patch have fallen from 10.0 to 3.0 and it is now
favourite. The odds on Bank Balance have increased from 2.5 to 9.0 and
the odds on Arbit are now 10.0, from 4.0. You therefore place the
following bets on a betting exchange:

The amount of profit that is made depends on which horse wins. Again, this is best expressed in the form of a table:

Race Winner

Profit

Purple Patch

£35 (£25 + £5 +£5)

Bank Balance

£35 (£25 + £5 +£5)

Arbit

£25 (£15 + £5 +£5)

Any other horse in same race

£15 (£5 + £5 +£5)

The stakes associated with bets 1 – 6 could have been amended such
that no matter which horse wins, the profit will be exactly the same.
Given that the calculations and method to achieve this are somewhat
complicated, it will be covered in a future article. The method, for
those interested, is called ‘Dutching’.

Lesson # 4

Notice also that the arbitraging profit is cumulative in that the
overall profit is the sum of the arbitraging profits made on the three
individual horses concerned.

So, no matter what the race outcome is, no matter who wins the race, a maximum of £35 and a minimum of £15 will be won.

Two hours before the start of the race, you receive a phone call from
the friend that you received the e-mail from. He tells you that he has
received a tip from a stable lad at another yard that a horse called
‘Getting Better’ will win the race in which Purple Patch, Bank Balance
and Arbit are are also running. When Getting Better last ran, his
performance was well below par. Hence, the horses’s current odds of
12.0. A visit from the vet, following the race, revealed that the horse
was suffering from a virus. Getting Better is now completely
virus-free and has been putting in some stunning performances on the
gallops lately. This information is known to few people. Hence, the
horse’s odds.

From this latest information you conclude that Getting Better’s odds
will fall dramatically when the latest information begins to circulate
and that the odds on Purple Patch, the current favourite, will increase.

It is now 1 hour before the race begins. The odds on Getting Better
have dropped to 2.0 and the odds on Purple Patch have increased to 6.0.
You therefore place the following bets on a betting exchange:
Bet 9. £10 lay bet on Getting Better at odds of 2.0.
Bet 10. £5 win bet on Purple Patch at odds of 6.0.

Now let’s look at the net effect of the latest four bets and the profit made on each of the two horses:

Getting Better

Wins

Loses

Bet 7

+£55

-£5

Bet 9

-£10

+£10

Net Effect

+£45

+£5

Purple Patch

Wins

Loses

Bet 8

-£20

+£10

Bet 10

+£25

-£5

Net Effect

+£5

+£5

Now let’s look at the overall affect of the 10 bets. Again, the
amount of profit that is made depends upon which horse wins the race.
As before, this is best expressed in the form of a table:

Race Winner

Profit

Purple Patch

£45 (£25 + £5 + £5 +£5 + £5)

Bank Balance

£40 (£25 + £5 + £5 + £5)

Arbit

£30 (£15 + £5 + £5 + £5)

Getting Better

£60 (£45 + £5 + £5 + £5)

Any other horse in same race

£20 (£5 + £5 + £5+ £5)

Notice again that the arbitraging profit is cumulative in that the
overall profit is the sum of the arbitraging profits made on the
individual horses concerned.

So, no matter what the race outcome is, a maximum of £60 and a minimum of £20 will be won.

When should I place my bets?

This is not a particularly easy question to answer since odds are
continually changing. The odds of some horses will continue to drift
out from the point that the market opens to the point when the race
begins. Some horse’s odds do the opposite. They continue to shorten.
The movement of the odds on some horses resembles that of a yoyo – up
and down all day. Therefore, there is no right or wrong time to place
your bets. If bets are placed early, the odds may decrease afterwards.
This means that the liability on lay bets could have been decreased had
the bet been placed later. On the other hand, the odds may increase
which would mean increased liability on lay bets. It was just as well,
therefore, that the bets were placed early. At this time, we are not
aware of any reliable method which accurately predicts the movement of a
horse’s odds.

There is, however, a rule of thumb which can be used when arbitraging
bets: Determine how much arbitrage profit on a given horse you
require. Place the initial bet as soon after the market on the race
opens. Leave the placing of the arbitraging (second) bet until as late
as possible. Sometimes, placing the second bet whilst the race is being
run can often pay handsome dividends. This ensures that the maximum
time is made available in which to arbitrage bets. Also, bets should be
arbitraged when the odds on the selected horse(s) have increased to the
point where the arbitrage profit requirements have been satisfied,
rather than waiting for the odds to increase, or decrease, still
further. That way, the profit is secure.

A point worth noting is that the odds required may exist on the
exchange for a few seconds only and may disappear as quickly as they
appeared. To avoid the disappointment of missing the required odds, it
is advised that the second bet is created shortly after the first bet
has been matched on the betting exchange. The second bet should contain
the stake and the odds required. The bet should then be submitted and
will remain on the exchange in an unmatched state until such time as the
required odds become available. If they do, the bet will be matched
and the required arbitrage profit will have been secured. Be aware,
however, that if a horse, running in the same race, is withdrawn at any
time following the placing of the second (unmatched) bet, or the second
bet has not been matched by the start of the race, the bet will be
cancelled by the betting exchange. If this happens, simply regenerate
the bet and place it on the system to await matching. The method of
placing an unmatched bet on the system to await matching means that you
are not required to sit in front of a computer screen for hours on end
waiting for the required odds to become available.

Bookmakers and Betting Exchanges

As has now become apparent, arbitraging involves the placing of a win
bet and a lay bet on the same horse. The high street bookmakers do not
allow members of the public to place a lay bet on a horse. As a
result, you must place your lay bet on one of the betting exchanges.
The win bet, however, can be placed either on one of the betting
exchanges or with one of the high street bookmakers. The bet can even be
placed with a high street bookmaker over the internet, or by phone, if
required. You could therefore sign onto a betting exchange using one
internet session and sign onto a high street bookmaker using a second
internet session and monitor the odds in both systems with a view to
taking advantage of the odds differential between the two systems in
order to arbitrage a bet. Open Several Bookmaker accounts to ensure you
can always get the best odds available.

Commission and Betting Exchanges

Betting exchanges charge a commission on winning bets. In the case
of the Betfair betting exchange, the maximum commission charged on
winning bets is 5% although this reduces in line with an increase in
betting activity.

Therefore, when using a betting exchange, remember to include any
commission levied on winning bets when considering arbitraging.

Arbitrage Calculations

For those who arbitrage their bets on a frequent basis and whose
mental arithmetic is lightening fast, arbitrage calculations should not
pose too many issues. For the remainder of us mere mortals and for
those who are new to arbitraging, a spread sheet is probably the best
way to calculate arbitrage profits in advance of arbitraging bets. To
help you, we have created a spreadsheet to assist those would-be
arbitragers amongst you. Please have a look at them, understand them,
play with them and use them in your arbitraging exploits.

Arbitrage Software

Arbitrage software is available for those who wish to concentrate on
this aspect of horse racing. However, it doesn’t do anything which
can’t be performed manually. The software just does it quicker, more
efficiently and more effectively.

Lesson # 5

Tips and Hints

1. Before beginning your arbitraging activities, ensure that you fully understand the theory, methodology and implications.

2. Test it out on paper first.

3. When you first start to arbitrage with real money, use small
amounts initially. That way, you are able to eliminate any
misconceptions that you had about arbitraging at a minimum cost to
yourself.

4. Be patient. Learning to become a good arbitrager doesn’t come overnight.

5. Accept that you will make mistakes and that this is all part of the learning process.

6. If you think that the odds on a horse will decrease, place the win
bet first and wait until the odds fall before placing the lay bet.

7. If you think that the odds on a horse will increase, place the lay
bet first and wait until the odds to increase before placing the win
bet.

8. If you intend to arbitrage a win bet, ensure that you have every
expectation that the horse will win. The odds may move only slightly,
or may not move at all or may move in the wrong direction. This will
prevent you from arbitraging your bet and, if the horse doesn’t win, you
will lose your stake.

9. If you intend to arbitrage a lay bet, ensure that you have every
expectation that the horse will lose. The odds may move only slightly,
or may not move at all or may move in the wrong direction. This will
prevent you from arbitraging your bet and, if the horse wins, you will
lose your money.

10. Place the first part of your arbitrage bet on the market as soon
as possible and place the second part of the arbitrage bet as late as
possible. However, once your intended arbitrage profit has been
realised, arbitrage your bet. Do not wait until the odds get any higher
or any lower, they may change direction and you will regret the fact
that you didn’t arbitrage your bet when the opportunity arose.

11. Prior to placing your initial bet, create a plan which relates to
your actions regarding the arbitraging of a bet. Be prepared for all
circumstances so that, if and when they occur, you have a solution to
hand. Do not place yourself in the position of having to make an on the
spot decision when you are under pressure, especially during in-running
arbitraging i.e whilst the race is in progress. As you become more
proficient at arbitraging, you will begin to realise what issues arise
and what the possibilities and solutions are. Here are a few examples:
What if the favourite is withdrawn after I have layed the second
favourite? What if the odds on my selection change dramatically (for
better or for worse) after I have placed a bet on it? What if one of my
selections is withdrawn and I have placed bets on other horses in the
same race?

betbubbles

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